Black Gold Outlook

The Daily Reckoning Presents: A Guest Essay

Stepping up regulation, OPEC is making itself the “energy Greenspan.” But investors take note: Given uncertainties in the Middle East, controlling prices this winter may be an impossible dream.


There is no apparent reason to expect higher crude oil prices anytime soon. But neither is there any apparent reason to expect them to slide. “Range-bound” is the choice term among the black gold experts with whom we spoke. This tepid and agreeable forecast may pan out.

Then again, tepid goes with oil about as naturally as does water. Less-than-obvious reasons abound for a price move, both in the near- and long-term. And investors are well advised not to forget the Middle East, that mother of all wildcards.

The late 1990s gave the world rock-bottom oil prices while giving OPEC members serious economic stress. Determined to exert more control, OPEC now meets about as often as the Federal Reserve Board to regulate its output and keep prices within its window of $22 to $28 per barrel.

Just this month, OPEC halted a modest oil slide by announcing a million barrel-a-day cut effective Sept. 1. “Being range-bound keeps OPEC countries very happy,” says Jeffrey Pittsburg, an oil analyst at Pittsburg Research.

Cutting output by one million barrels a day could be just the catalyst to drive prices near $30, especially by December, says Aaron Brady of Energy Security Analysis, Inc. The world crude oil market is already headed toward a deficit this winter, which the September OPEC cut is bound to influence even more. Also on the side of short-term higher prices is a large speculative short position in crude oil. Brady points to a Commitment of Traders report indicating that early this month the Non-Commercials (speculators) had built up their biggest net short West Texas Intermediate (WTI) position since the collapse of oil prices in 1998.

In and of itself, this large short position is not automatically significant. But if prices begin to move higher for any reason, short covering could amplify the move. “If OPEC is successful in driving back the price up, then you’ll have the additional effect of short covering going on,” said Gareth Roberts, chief executive of Denbury Resources, a large oil and gas producer. “It’s OPEC versus the NYMEX. When OPEC says we’re going to shorten some production they’re squeezing the shorts. Something has to give somewhere.”

Veteran oil analyst Tom Petrie, co-founder of Denver’s Petrie Parkman & Co., says that futures markets tend to influence oil prices when supply and demand conditions are tight. “There are times you can argue that the tail wags the dog when it comes to the futures markets,” he says. “That’s where OPEC’s intervention can put a floor under it. When times are tight, the great commodity traders can have some influence. They certainly affect perception and psychology, which can then enter into OPEC’s calculations and mindset.”

If short-term trading can influence prices, so can long- term demand trends. To be sure, sluggish economies have slowed their demand for oil this year, but demand nevertheless continues to grow.

Gasoline prices have inched up on news that inventories dipped for the seventh week in a row. Scott Inglis, managing director of First Energy Capital Corp., an investment firm focused on the Canadian energy sector, points out that talk of economic slowdown has not done much to hurt gasoline demand in the U.S., which has remained remarkably strong throughout the summer.

First Energy recently lowered its forecast for global crude oil demand growth to 0.6% in 2001, down from its long-predicted 0.8%. An Asian slowdown and higher oil prices have dampened demand throughout the region. In fact, all of the major oil-consuming markets are discouraged by the fact that WTI prices have hovered above $25 for more than 18 months, the first time that has happened since the mid-1980s, according to Inglis.

But don’t count out the emerging nations. A study this month by the International Energy Agency shows that crude oil demand by the OECD countries dropped 0.5% year-over-year in May, and early data suggest that demand might drop off even faster in June. But thanks to rising developing world demand, the IEA predicts that global oil demand will still grow by 0.5 million barrels a day this year and 0.8 million barrels a day in 2002.

It is important to note that non-OECD oil demand has consistently exceeded IEA forecasts. Acknowledging this fact, the agency estimates that if past is prologue in 2001 and 2002, total world oil demand could rise an additional 0.4 million barrels per day beyond the IEA’s current forecasts. In other words, expect an upside surprise on the demand side.

Because OPEC, which accounts for more than 40% of the world’s output, is determined to monitor “range-bound” prices, the expectation is that oil prices will hover in the mid-$20s well into the winter. But Inglis says that every time he forecasts oil prices, OPEC surprises him with a cut to hold prices a bit higher.

The group of 11 has also been extremely proactive in making cuts well ahead of when it needs to, he says. “We’re predicting $26.25 for the rest of this year, which looks a little light now because of the recent OPEC cutbacks,” says Inglis. “But somewhere in the $27 range is probably where it shakes out.”

A new era of constant OPEC supply-tinkering is a response to a more unpredictable world, not the cause of it, says Tom Petrie. “In making its changes more frequently the idea is to diminish volatility, not increase it,” he says. OPEC has been successful of late, but it’s a delicate balance. Indeed, the regulation of the bulk of the world’s oil supply is in some respects analogous to the regulation of money supply by the Fed, according to Petrie. “In the same vain that Alan Greenspan has become the master of gradualism, OPEC is looking to do something similar,” he says. “The comparison is irresistible: The two life bloods of economic activity are money supply and energy and OPEC is in a sense the world’s Fed for energy supply.”

Denbury’s Roberts says that OPEC used to take a stab at what amount of oil the world would need for the year and produce it at that rate. And the western world would store the oil. By the time the Asian crisis hit in the late 1990s, the perception that there was a world oversupply drove prices down dramatically, a lesson OPEC never forgot.

He, too, likens OPEC to a kind of Federal Reserve for the world energy industry, meeting almost monthly to tweak production numbers in an effort to keep crude oil around the $25 per barrel mark. “What OPEC is doing for the first time is trying to manage the inventories around the world by adjusting their output,” says Roberts. “They’ve never done this before. It’s most unusual.”

Just as forces in the near and long term have the potential to jolt OPEC’s precious target prices out of range, so can a wildcard: growing violence in the Middle East. Of OPEC’s 11 member countries, five are in the region and another three are fellow Muslim countries.

We say, expect the unexpected. Despite OPEC’s considerable influence, it’s a reasonable bet that the cartel will not maintain a perfect supply and demand balance in the oil market. Most likely, oil prices will test the high end of the target range sometime this winter. Oil demand continues to surprise on the upside, both short- and long-term.

Toss in a Middle East that is becoming less peaceful every day and suddenly, oil looks like one commodity that is better bought than sold at current prices.


Jay Akasie
September 5, 2001

for The Daily Reckoning

Jay Akasie is a writer for and a regular contributor to The Daily Reckoning. As a reader of the Daily Reckoning you are cordially invited to try for 30 days – free. Please click here: Grants Investor

*** Let’s see, Ol’ Ferdinand – our latest bull market indicator – was spotted in the north part of the field in the early morning…but then he wandered back towards the middle.

*** Sure enough, Ol’ Ferdinand was right. Stocks soared in the morning yesterday….but then came back, with the Dow closing just 47 points ahead and still under the 10,000 mark.

*** The Nasdaq closed down 34 points.

*** For those who watch such things, this is not ‘good action.’ Investors must have been so eager to get out that they sold into the morning’s powerful rally. But who knows…we’ll have to keep an eye on Ol’ Ferdinand. He’s as good an indicator as any.

*** This morning, I note that the old bull is grazing in the south section of the field, next to a group of cows. Look for falling stock prices today. (I’ll warn Ferdinand that if he gets this wrong, he might soon be filet mignon.)

*** On-line sales fell again in the 2nd quarter. On-line retailers took in fewer dollars and a smaller share of total retail revenues.

*** “The Internet is great for investors,” wrote Doug Casey two years ago. “But it will be a graveyard for his capital.” I reported Dr. Richebacher’s comments yesterday – noting that the entire technology sector was losing money. And now comes a study done by former Treasury Secretary Larry Summers that confirms Doug’s intuition.

*** “The paper, written along with economist Bradford DeLong, was prepared for the weekend’s top-level gathering of central bankers and economists.

*** “The future of the technology is bright; the future of the profit margins of businesses-save for those few that truly are able to use economies of scale to create mammoth cost advantages-is dim,” it concluded.

*** “This means that in the long run, consumers will reap large benefits from the technological revolution, but that the path may be rocky for investors…Consumers will gain, and shareholders will lose,” the paper said.

*** Shareholders have already lost an amount equal to half the nation’s GDP. Between $4 and $7 trillion have disappeared from stockholders’ net worth since the crash of the Nasdaq and the beginning of the bear market.

*** Yesterday, the Dow rose, but losses in technology continued. Our ‘river of no returns’ stock, Amazon, dropped below $9…Cisco slipped below $16.

*** The dollar rose handsomely yesterday – ending the day up to 88 cents per euro. So far, the dollar has resisted our efforts to guess when it might fall…

*** “The dollar will lose at least 20% to 30% of its value against the euro,” we recall Dr. Richebacher saying over the weekend. Dr. Richebacher was right about the tech sector and the Nasdaq. We think we will be right about the dollar, too. Dr. Richebacher, of course, has some thoughts on what you should do if you’re planning to profit from the situation.

*** Last night, we came to the end of the series of conferences and seminars out here in Ouzilly. Thom, the other musicians, and I got together and did a few songs for the group. We sang 3 or 4 songs and then signed off. ‘But the crowd cried out for more,’ as Percy Sledge put it. It was the first time we were ever asked for an encore! Hmmm….maybe it’s time to quit our day jobs and go on the road.

*** But wait…what about all those hotels…the booze…the drugs…the groupies? Hmmm, sure sounds better than watching the stock market for a living.

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